The Austrian Theory of the Trade Cycle and Other Essays
By Ludwig von Mises, Gottfried Haberler, Murray N. Rothbard,
Friedrich A. Hayek, Richard M. Ebeling (Editor)
Ludwig Von Mises Inst.
125 pgs. $9.95
ISBN: 0-9454-6621-8
Answering questions about the Austrian School
By Jason Kauppinen
web posted September 2, 2002
Business cycles affect the lives of all people; from the
entrepreneur to the average citizen. Naturally these cycles are the
subject of a great deal of study by economists. For instance, the
disciples of Keynesian theory contend that insufficient consumer
demand is the cause of bust periods in the trade cycle.
Consequently they tout government manipulation of consumer
spending as a cure. The Monetarists, however, see bust periods
as a failure of central bank policy to provide enough liquidity. In
response, they advocate government manipulation of the money
supply through a central banking system. Both of these schools
of thought however, are unable to adequately answer the simple
question that Murray N. Rothbard asks within his essay
"Economic Depressions: Their Cause and Cure".
"...the market economy has a built-in natural selection mechanism
for good entrepreneurs, this means that, generally, we would
expect not many business firms to be making losses. And, in fact,
if we look around at the economy on an average day or year, we
will find that losses are not very widespread. But, in that case,
the odd fact that needs explaining is this: How is it that,
periodically, in times of the onset of recessions and especially in
steep depressions, the business world suddenly experiences a
massive cluster of severe losses? A moment arrives when
business firms, previously highly astute entrepreneurs in their
ability to make profits and avoid losses, suddenly and
dismayingly find themselves, almost all of them, suffering severe
and unaccountable losses?" (Rothbard, pg 64)
These questions are answered by the Austrian Theory of the
Trade Cycle; a theory fully outlined by the book "The Austrian
Theory of the Trade Cycle and Other Essays". This slim
paperback contains the aforementioned essay by Murray N.
Rothbard, as well as essays from Ludwig von Mises, Gottfried
Haberler, and Friedrich A. Hayek. Roger W. Garrison also
contributes an introduction and a summary. The trade cycle
theory that these five writers support is profoundly different from
both Keynesian and Monetarist theory.
Gottfreid Haberler's essay, "Money and the Business Cycle" is a
step by step explanation of the Austrian Trade Cycle Theory.
The Austrian theory contends that the boom-bust cycles of
modern economies are actually caused by centralized
government run banking systems. These act as a catalyst for the
creation of ultimately unprofitable projects by private banks.
Haberler explains how the allocation of capital is central to the
Austrian theory. He contrasts the Austrian's view of capital as
something that is added to and also changed over time in
reaction to different business conditions with the Keynesian view
of capital as a fixed, monolithic, unalterable stock. He then
details how the theory is used to explain how a government
manipulated interest rate distorts the flow of capital and causes
both the boom and the bust portions of the trade cycle. Finally
he explains what role a bust period plays in attempting to correct
a government induced distortion of the capital structure.
Ludwig von Mises' essay "The 'Austrian' Theory of the Trade
Cycle" begins by outlining the theory's origins. It is based in part
on the English "Currency School" but improves upon its two
major defects. The first error is that it omits the role of current
accounts in monetary expansion. The second is its narrow focus
on credit expansion within one country only. Austrian school
authors such as Mises and Hayek modified and expanded the
theory to cover the case of central banks in multiple countries
engaging in monetary manipulation simultaneously. Mises then
shows how the Austrian theory can be used to explain the origins
of the economic difficulties that Germany experienced in the
1920's and 1930's. He concludes his essay with a brief
examination of bank policy options during depressions.
Friedrich Hayek titles his essay with a rhetorical flourish: "Can
we still avoid Inflation?". He proceeds to cover the first the well-
known destructive effect of inflation among borrowers and
lenders as well as its lesser-known effect of distorting the capital
structure of an economy. Hayek also shows how the Keynes'
idea of uniform inflation was nonsensical, and how public policy
based upon it must be ultimately destructive.
Roger W. Garrison's introduction presents a broad overview of
the development of the Austrian trade cycle theory. Of particular
interest is his observation that the Austrian theory was typically
included in economics texts until the 1930s. It then lost
prominence in the wake of the "Keynesian Revolution" that
occurred after the publication of Keynes' General Theory of
Employment Interest and Money. Garrison maintains that
Keynes' theory overtook the Austrian trade cycle theory
because Keynes' theory was both simplistic enough for policy
makers to understand, and attractive enough to follow. In his
words: "An easy-to-follow recipe for managing the economy
won out over a difficult-to-follow theory that explains why such
management is counterproductive." Garrison's summary shows
how the Austrian trade cycle theory can be explained using
graphed aggregates. These abstractions are only useful in
showing, in a very simplified way, how the theory operates. In
the real world, the expansion and later contraction would first
occur in the capital goods areas and then proceed through the
economy from there.
Each of the four essays as well as the introduction and
conclusion contain a manageable level of footnotes; and the final
page of the work contains a list of suggested further reading.
This is Jason Kauppinen's (Lycurgus33@hotmail.com) first
contribution to Enter Stage Right.